Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Anthem, Inc. (NYSE:ANTM) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Anthem's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2021 Anthem had US$22.8b of debt, an increase on US$20.8b, over one year. However, it does have US$34.0b in cash offsetting this, leading to net cash of US$11.2b.
A Look At Anthem's Liabilities
The latest balance sheet data shows that Anthem had liabilities of US$35.2b due within a year, and liabilities of US$27.1b falling due after that. On the other hand, it had cash of US$34.0b and US$12.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$15.6b.
Since publicly traded Anthem shares are worth a very impressive total of US$111.2b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Anthem also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Anthem saw its EBIT drop by 9.3% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Anthem can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Anthem has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Anthem recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
Although Anthem's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$11.2b. And it impressed us with free cash flow of US$9.5b, being 91% of its EBIT. So we don't think Anthem's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Anthem is showing 1 warning sign in our investment analysis , you should know about...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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